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Changes in Background Risk and Risk Taking Behavior

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  • EECKHOUDT, Louis
  • Christian GOLLIER
  • Harris SCHLESINGER

Abstract

We consider the effects of changes in the distribution of a background risk on the optimal risk taking behaviour of a risk- averse decision maker. In particular, we suppose that the background risk deteriorates via a first- or second-degree stochastic dominance shift. Our contention is that such a change in background wealth should lead the individual to behave in a more risk-averse manner in decisions concerning any other independent risk. We examine conditions on preferences that are both necessary and sufficient for all FSD or SSD changes in background wealth to entail this property. These conditions place restrictions on the stronger measure of risk aversion defined by Ross [1981].

Suggested Citation

  • EECKHOUDT, Louis & Christian GOLLIER & Harris SCHLESINGER, 1994. "Changes in Background Risk and Risk Taking Behavior," Working Papers 005, Risk and Insurance Archive.
    • Handle: RePEc:wop:riskar:005
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    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    2. Meyer, Jack & Ormiston, Michael B, 1985. "Strong Increases in Risk and Their Comparative Statics," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 425-437, June.
    3. Miles S. Kimball, 1991. "Precautionary Motives for Holding Assets," NBER Working Papers 3586, National Bureau of Economic Research, Inc.
    4. Doherty, Neil A & Schlesinger, Harris, 1983. "Optimal Insurance in Incomplete Markets," Journal of Political Economy, University of Chicago Press, vol. 91(6), pages 1045-1054, December.
    5. Elmendorf, Douglas W & Kimball, Miles S, 2000. "Taxation of Labor Income and the Demand for Risky Assets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(3), pages 801-833, August.
    6. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May.
    7. Gollier, Christian & John W. PRATT, 1993. "Weak Proper Risk Aversion And The Tempering Effect of Background Risk," Working Papers 018, Risk and Insurance Archive.
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